Self-funded employers spend months vetting stop-loss carriers, provider networks, and third-party administrators (TPAs) before a plan document is ever signed. The pharmacy benefit manager, or PBM, rarely gets the same scrutiny, even though it typically represents 20 percent or more of total plan spend and is often the fastest-growing line item on the claims side.
Roughly 70 PBMs operate in the United States, and a small handful manage prescription benefits for the large majority of insured Americans. Understanding what a PBM actually does, and how to tell one model apart from another, gives employers real leverage in a market that has historically depended on plan sponsors not asking too many questions.
What a PBM actually does
A pharmacy benefit manager, or PBM, is the vendor a health plan hires to administer the prescription drug portion of its benefits. For a self-funded employer working with a third-party administrator on medical claims, the PBM handles a parallel set of responsibilities specific to pharmacy. Those responsibilities generally fall into four areas:
- Formulary management, which determines which medications are covered and what tier of cost-sharing applies to each one.
- Pharmacy network contracting, covering the retail, mail-order, and specialty pharmacies members can use.
- Claims adjudication, the real-time approval and pricing that happens at the pharmacy counter.
- Rebate negotiation with drug manufacturers, often the largest and least visible source of PBM revenue.
Pharmacy is frequently bundled into the broader ancillary benefits conversation during plan design, which is part of why the PBM selection gets less independent attention than it should. It is a standalone contract with its own pricing model, its own performance guarantees, and its own risk if the terms are not well understood.
Not all PBMs are built the same way
Most of the pharmacy benefit market runs through a small number of large PBMs affiliated with national health insurers and their own specialty pharmacy operations. That scale can bring negotiating power on drug pricing, but it can also mean less visibility into where costs actually land, since the PBM, the pharmacy filling the prescription, and sometimes the insurer are all part of the same parent organization.
Independent PBMs operate outside that structure. Some go a step further on pricing models as well, offering transparent or pass-through arrangements where the PBM charges a flat administrative fee and passes 100 percent of manufacturer rebates and pharmacy discounts back to the plan, rather than retaining a spread between what it charges the plan and what it pays the pharmacy.
Neither structure is automatically the right answer for every employer. A transparent PBM removes a category of conflict of interest, but plan sponsors should still confirm claims-level reporting and audit rights regardless of pricing model. And the pricing model is only one variable. The more consequential question for most employers is what the PBM actually costs after every fee, rebate and spread is accounted for, which is rarely the number printed on the first page of a proposal.
Why PBM selection carries more weight than a standard vendor decision
For a self-funded employer, choosing a PBM is not purely a procurement decision. Under ERISA, plan sponsors act as fiduciaries and carry a legal duty to select and monitor service providers prudently, including PBMs. A growing number of lawsuits have targeted employer plan fiduciaries directly over PBM contracts, alleging they accepted opaque pricing or a broker’s recommended vendor without independently verifying the terms. That litigation trend, combined with new federal disclosure rules, has raised the practical stakes of an evaluation that many employers used to treat as a formality.
Regulators are moving in the same direction. A proposed Department of Labor rule would require PBMs serving self-insured ERISA plans to disclose direct and indirect compensation in far more detail than most contracts currently call for. A separate FTC staff report has documented how opaque pricing arrangements can inflate costs well beyond what plan sponsors are able to see in standard reporting, and federal policy research tracking these reforms notes that market consolidation among the largest PBMs is a central reason lawmakers are pushing for more disclosure. The direction of all three is the same: employers who ask for detail up front, and document that they did, are in a stronger position than those who accept a standard contract as-is.
A framework for evaluating a PBM
Comparing PBMs on the administrative fee alone is the most common mistake employers make, and it is an easy one to avoid with the right questions. A more useful evaluation looks at:
- Net cost, not sticker price. A competitive admin fee paired with aggressive spread pricing or low rebate pass-through can cost more overall than a higher fee with full transparency. Ask for net pharmacy cost after every fee and rebate, not the numbers in isolation.
- Rebate pass-through language. Does the contract guarantee 100 percent pass-through in writing, or does it leave room for the PBM to retain a portion?
- Audit rights and reporting granularity. Can the plan sponsor, or a third party on its behalf, verify claims-level pricing by National Drug Code, rather than relying on an aggregated quarterly summary?
- Consultant and broker compensation. If a third-party administrator (TPA) or broker is recommending a specific PBM, ask directly whether that recommendation comes with compensation from the PBM. A legitimate relationship can still create an incentive worth understanding before relying on the recommendation.
- Specialty and high-cost drug handling. Specialty medications and newer high-cost categories like GLP-1s increasingly drive total drug spend. Ask how the formulary and utilization management approach these categories specifically, not just the plan overall.
- Contract flexibility and data portability. What does it take to exit or renegotiate if performance guarantees are not met, and can claims history actually be exported in a usable format if the plan switches PBMs later?
- Coordination with the TPA. Pharmacy and medical claims should not operate in silos. A PBM that will not share data with the plan’s medical management team makes it harder to catch drug interactions, manage high-cost specialty claims, or simplify overall benefits administration for the employer.
Frequently asked questions regarding PBM selection
Can an employer switch PBMs before the plan renews, or does it have to wait for open enrollment?
Most PBM contracts run on their own terms separate from open enrollment, and many include termination clauses tied to performance guarantees rather than a fixed renewal date. Employers who feel locked in until the next plan year should have their broker or TPA review the actual termination language rather than assuming the contract and the plan year move together.
Does contracting a smaller or independent PBM mean giving up negotiating leverage on drug pricing?
Not necessarily. Many independent PBMs access manufacturer rebates through a group purchasing organization that aggregates volume across multiple clients, which can offset some of the scale advantage that large, integrated PBMs rely on. The tradeoff is usually worth evaluating case by case rather than assuming bigger always means better pricing.
If the PBM is a separate vendor from the TPA, who is responsible for catching pharmacy claims errors?
This depends entirely on the contract and should not be left ambiguous. Some employers assign oversight to their in-house medical management partner even when the PBM is a separate vendor, specifically so pharmacy and medical claims are reviewed together instead of in isolation.
Is a formal RFP necessary for a smaller self-funded employer, or is that overkill below a certain group size?
Group size affects how much leverage an employer has in negotiation, not whether the fiduciary duty to evaluate carefully applies. Smaller employers can scale the process down, focusing the evaluation on the framework above rather than running a full multi-vendor bid, but skipping the review entirely because the group is small is the pattern that tends to draw scrutiny if a plan is ever audited or challenged.
Where BHPS fits into the PBM conversation
BHPS is not a PBM. As a neutral third-party administrator, our role is to help self-funded employers manage the relationship, not add another layer to it. Our in-house clinical team works alongside whatever PBM a plan has selected to review high-cost claims, catch coordination gaps between pharmacy and medical benefits, and help employers evaluate whether their current PBM contract still reflects their goals as those goals change.
If your organization is reviewing its PBM contract, or evaluating one for the first time, connect with the BHPS team to talk through what a stronger arrangement could look like for your plan.